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In our first and second articles in a three-part series on shareholder activism in Japan, we reviewed the history and evolution of activism in Japan, and then introduced our Japan equity investment team’s approach to engagement and value realization. In the final article within this series, we share how Wellington’s ESG team works with the Japan equity team to proactively engage companies and support investor efforts to realize value on relevant portfolios.
We believe, firstly, that material ESG issues are strategic business issues that can impact share price performance, hence understanding them enables more informed investment decisions. Secondly, we believe that we can support actions that benefit our clients through informed and active ownership. These two beliefs shape our non-concessionary approach to ESG on relevant portfolios.
Our team of ESG analysts, many with backgrounds in fundamental investing, functionally sits within the broad investment research resources of the firm. Coverage is split by region and sector. These factors potentially help ensure ESG integration is investment-led as well as contextualized to the nuances of each region and sector.
The growing number of activist funds operating in Japan has been well-documented1. Many topics of activist focus are governance related, such as improving board gender diversity, shareholder returns, and reducing cross shareholdings. Increasingly, activists are focusing on environmental disclosures.
1Reuters,01-31-23, https://www.reuters.com/markets/asia/tokyo-booms-shareholder-relations-advisers-activists-raise-pressure-2023-01-31
Activists’ interests may, however, not necessarily be aligned with investors’ long-term interests, and, by extension, clients’ interests. Industry studies suggest the average holding period of an activist investor is just four to six quarters, and the intrusive ways demands are made can be a source of distraction and, at times, even embarrassment for the board, which can ultimately be to the detriment of the company.
Against this backdrop, we believe it is our fiduciary duty to help companies get in better shape before an activist shows up and forces them to. In collaboration with Wellington’s ESG team, our Japan equity team has consistently done this by 1) building long-term relationships with companies and pushing for board access, which allows us to support and advise companies; 2) clearly communicating our voting guidelines and rationale specific to Japan every year via outreach letters heading into proxy season; 3) increasing our willingness to vote against management on a particular resolution; and 4) providing recommendations formally to the board via board letters if deemed necessary.
One such example is a Japanese machinery company, which has operationally underperformed regional peers despite being the technology and market-share leader in its core business. The company was also below book value, with excess cash on its balance sheet. We believed, based on our experience and numerous global case studies, that these were traits that could potentially attract activists.
Early in 2023, our ESG team, working alongside our Japan equity team and a Wellington global industry analyst (GIA), engaged with the company to recommend further preemptive defenses such as 1) board refreshments, since its more-than-a-decade board tenure far exceeded the five-year average tenure at TOPIX 100 companies; 2) more independence in subcommittees in response to an outsized family representation; and 3) for noncore business to be reassessed. This engagement was, in fact, a continuation of our longer-term value creation engagement effort with the company, which has contributed to their improved board independence, adoption of restricted stock plan for directors, and increased buyback.
Beyond playing defense, we believe engagement also helps with offense. This is best illustrated by a case study of a Japanese auto company, whereby a tripartite formed of our Japan equity team, ESG analyst, and GIA actively used voting and engagement to help the company improve its value over the long term. In the period since October 2020, we sent three letters to the board and held multiple engagement meetings, with the focus being on capital return, balance-sheet optimization, board structure, and disclosure of decarbonization efforts.
Fast forward to 2023, several tangible outcomes resulted from these active ownership efforts, including:
Understanding the opportunities and nuances of shareholder activism in Japan is an important source of value creation for investors in this market, and we believe the Japan equity team’s long track record of integrating active engagement into its investment process, coupled with Wellington’s global scale and centralized investment research function, puts us in a strong position to be thought partners for companies and to drive positive investment outcomes for clients.
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Toshiki Izumi, CFA, CMA